Liftoff remorse? Don't blame Fed for turmoil, Yellen says

(Bloomberg) — Federal Reserve Chair Janet Yellen said the central bank was not to blame for the tumult that has engulfed financial markets this year and is unlikely to roll back its December interest-rate increase in response.

Winding up two days of testimony on Capitol Hill, Yellen argued that the Fed's first rate rise in nine years had been widely anticipated by investors and so prompted scant angst in the markets. It was only after the start of the year that trading turned turbulent in response to a depreciation of China's currency and a dive in oil prices, she said.

"Those things have been the drivers and have been associated with broader fears that have developed in the market about the potential for weakening global growth with spillovers to inflation," Yellen told the Senate Banking Committee on Thursday. "I don't think it's mainly our policy."

With the central bank already in Congress's crosshairs on a variety of issues from regulatory policy to the transparency of its operations, the last thing it needs is to be blamed for making a monetary policy error by raising rates prematurely.

Sam Coffin, an economist at UBS Securities LLC in New York, agreed with Yellen that the Fed's rate hike "seemed to go off without a hitch." But that didn't necessarily mean policy makers made the right call in ending seven years of near zero interest rates in December, he added.

Liftoff remorse?

"The combination of weakness abroad and a greater fear of spillover to the U.S. probably raises the question of whether the beginning of policy normalization came at the right time," Coffin said.

Yellen said the Fed was assessing the impact of the swings in the markets on the economy but she doubted that would prompt it to reverse course and cut rates. "It's not what I think is the most likely scenario," she said.

Traders seem to disagree. They are assigning a slightly higher chance to a Fed rate cut this year than an increase, according to overnight-indexed swaps data compiled by Bloomberg.

Yellen did say that the Fed was taking another look at negative interest rates as a potential policy tool if the U.S. economy faltered, a scenario some investors view as a mounting possibility amid a darkening outlook for world growth.

"We had previously considered them and decided that they would not work well to foster accommodation back in 2010," the Fed chair said. "In light of the experience of European countries and others that have gone to negative rates, we're taking a look at them again because we would want to be prepared in the event that we needed to add accommodation."

Legal doubt

She said she was not aware of any legal restriction preventing the Fed from cutting rates below zero, though she added the central bank had not made a full study of the issue.

Senate Banking Committee Chairman Richard Shelby said he doubts the central bank has such authority and indicated his counsel will review the legality of the tool as the central bank weighs its policy options.

"The Fed generally interprets the law to their advantage," Shelby, a Republican from Alabama, said in an interview Thursday in Washington. "We will have our counsel look into it. That's the question. I would doubt it, but I haven't personally checked it," he said when asked if the authority exists under current law.

– With assistance from Jana Randow, Alexandra Scaggs and Matthew Boesler.

Wall Street turmoil to bend, not break, economic expansion